Economic Snapshots from Roubini

by John Ballard

On this anniversary of 9/11 we observe the WTC tragedy of eight years ago, but it was about this time last year that I first heard the name of Nouriel Roubini, one of a small group of economists who predicted the global economic crisis now a year old and still in progress. I'm not a trained economist but training seems to have had little value for those who are, so here is a reading list I find interesting. It comes from the RGE (Roubini Global Economics) Newsletter

Daniel Alpert cautions that the recent run up in the stock market may be an echo of the "hope rally" of 1930, a similar "recovery" that was to be followed by an extended period of unemployment that ran for another twenty-five years...

The hope rally of 1930 ended on April 17th of that year, going into a long Good Friday weekend.
Interestingly, there was an unexpected closing of the Tokyo (then �Tokio� in the press) stock exchange
the day prior � which was widely reported and sent the U.S. markets slightly off kilter (think about the
recent declines on the Shanghai market), but other than that � as illustrated in source material below �
there was no real event that triggered the near-relentless decline that followed. The press of the day
indicates building concern over the market�s overvaluation, but there is absolutely no inkling of dread
that the market value reflected in the Dow index was about to disappear until 1954.

Augusto de la Torre and Alain Ize, two Latin America experts, take a look at regulatory reforms aimed at preventing another systemic collapse like the one which caused the current global financial crisis. Their article make me think of alchemists seeking a recipe for gold using everyday elements.

Our proposal ensures regulatory neutrality. Because the unregulated intermediaries could only fund themselves from the regulated, a dollar lent to a final borrower through an unregulated intermediary would end up paying the same Pigouvian tax as a dollar lent through a regulated intermediary. Hence, systemic risk would be evenly internalized across all possible paths of financial intermediation, whether they involve unregulated intermediaries or not. But, at the same time, and unlike the universal-banking-only solution, our proposed scheme would favor innovation and competition. Because the unregulated intermediaries would not need to meet entry requirements, they could start from scratch. This would facilitate the entry of the smaller and most innovative players, possibly into �niche� or �boutique� intermediation, where the value they add to intermediation is sufficient to offset their higher funding costs. The cost of oversight would remain low by effectively �delegating� supervision of the unregulated to the regulated intermediaries that lend to them under the general oversight of the supervisor. And the most successful of the unregulated intermediaries would eventually grow to become regulated, thereby gaining direct access to capital markets and retail deposits.

Admittedly, our proposal does not directly address the TBTF-TITF ["Too Big To Fail/ Too Integrated To Fail] problem. However, we do not think this is as severe a shortcoming as it may seem. First, it is simply wrong to equate systemic risk with TBTF-TITF. Systemic risk can be present even without TBTF-TITF... et cetera...[The reader is invited to go read and decide for himself.]

Lucien Bebchuk explains why executive compensation should have oversight by government and shareholders, a long-overdue need in the marketplace. I don't expect it to happen in any meaningful way for same reasons there will always be more Bernie Maddoffs. Greed and power go hand in hand, but it's fascinating to read the reasons.

It is important to distinguish between two sources of concern about pay in financial firms. One set of concerns arises from the perspective of shareholders. Figures recently released by New York�s attorney general, Andrew Cuomo, indicate that nine large financial firms paid their employees aggregate compensation exceeding $600 billion in 2003-2008 � a period in which their aggregate market capitalization substantially declined. Such patterns may raise concerns among shareholders that pay structures are not well designed to serve their interests.

Even if financial firms have governance problems that produce pay decisions deviating from shareholder interests, however, such problems do not necessarily warrant government regulation of those decisions. Such problems are best addressed by rules that focus on improving internal governance processes and strengthening investors� rights, leaving the choices that determine compensation structures to corporate boards and the shareholders who elect them.

But pay in financial firms also raises a second important source of concern: even if compensation structures are designed in the interests of shareholders, they may produce incentives for excessive risk-taking that are socially undesirable. As a result, even if corporate governance problems in financial firms are fully addressed, a government role in regulating their compensation structures may still be warranted.

That's all we really need. Better oversight of financial markets, reasonable compensation packages for executives and a pony.

In Why Did Economists Get It So Wrong? Krugman is Right Jeff Frankel comments on a Krugman piece in the NY Times,

I would only add that he is modest in skipping over one point: during Japan�s lost decade of growth in the 1990s Paul forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy � a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory. But macroeconomics went on as before.

How China Cooks its Books by Yves Smith looks at a piece in Foreign Policy Magazine.

We�ve commented from time to time on dubious Chinese data releases. But this report from Foreign Policy reports on an interest aspect: that the statistics are not manipulated only in the normal bureaucratic manner (fudging them) but also by getting companies to change behavior so it can be tallied in a more flattering fashion.

The story contains some real bombshells: unemployment is likely 40 to 50 million, as opposed to the widely reported 20 to 30 million; the statistical manipulations are a surprisingly broad-based initiative.

Now you know how I sometimes piss away the morning. And why they don't call it the "dismal science" for nothing. I'm ending this post with the piece that first got my attention, Mark Thoma's look at an excellent Ezra Klien piece, The Public Plan is Not the Same Thing as Price Control. 

The strongest public plan on offer is in the bill being considered by the House of Representatives. This plan is limited to the health insurance exchanges, which are in turn limited to employers with fewer than 20 workers. So that's the first point: The vast majority of Americans would be ineligible for the public plan, even if they wanted it. The CBO estimates that by 2019, the public plan would have a likely enrollment of 10 million Americans � and that estimate (pdf) imagines a world in which the exchanges are opened to businesses with 50 or fewer employees, which is to say, it's more favorable than the actual bill.

The end result is that the public plan is unlikely to have a very large customer base, which means it will be unable to use market share to bargain prices far lower than private insurers. That might not matter if the plan could attach itself to the rates that Medicare uses. In the first draft of the House bill, the plan could do that, at least for its first three or four years of existence, after which point it was cut loose from Medicare. But the deal Henry Waxman cut with the Blue Dogs erased that advantage, and now the public plan, even in the House bill, is on its own. That is to say, the plan has neither Medicare bargaining power nor the sort of customer base that gave Medicare its bargaining power.

Is that an argument against the public plan? Nope. There are real advantages to the presence of a public alternative. Competition matters, for one thing, and there are a lot of states where one or two private insurers essentially control the market. Experimentation matters, too, and the public plan could be used alongside Medicare to test payment reforms and disease management programs that could pay off in the long run. The public plan could also usher in a fairly radical level of transparency in pricing and behavior, forcing private insurers to follow suit. And lastly, the public plan is something of a corporate accountability measure. Its presence in the market ensures that health-care reform won't simply be a large reward to the insurance companies absent any serious changes in their behavior.

These were the original arguments for the public plan, and they're as strong today as they were then. But they are not the same as cost control. Cost control happens when we use less treatment, need less treatment, or pay less for treatment, and the public plans under consideration don't really do any of those things. In fact, the bills under consideration don't do any of those things, though I think they're a useful first step. This step in health-care reform is largely about expanding coverage and creating a structure � with universality and the exchanges and so forth � that will make cost control easier down the road. None of the bills, on their own, really do all that much to control costs.

This last paragraph contains a universe of wisdom. Universal participation in paying for public health is the essential first step, but it is just that, a first step. Over time the best and only real way to limit the cost of health care lies in a sea change in how America does medical care. The system must move from a disease management model to one of prevention of disease and responsible management of good health.

Until then, we are like a population of wealthy alcoholics who smoke, eat all the wrong things to excess and never bother to exercise. As long as we can afford to pay for all the bad consequences we ain't gonna worry.